If you are looking to down-size, purchasing a new or existing home with a reverse mortgage may be an attractive option! There would be no monthly payments, ever. Only single family residences qualify for this type of loan and the buyer must move in within 60 days.
The three largest closing costs are the FHA mortgage insurance, the origination fee, and escrow fees.
Typically, the only cost paid out-of-pocket by the borrower is counseling.
FHA Mortgage Insurance:
For the HECM standard, the upfront insurance premium is ~0.5% to 2.5%* of the property value up to the HUD property value limit.
The FHA insurance provides three guarantees:
The homeowner cannot “outlive” the reverse mortgage
The homeowner and heirs will not be personally liable if the balance of the loan exceeds the value of the home at the time of sale
The FHA will take over the loan if the lender becomes financially troubled
The FHA uses a formula to determine what the lender can charge.
2% of the first $200,000 of property value and 1% of the second $200,000 of property value
An absolute maximum of $6,000
Title guarantees the homeowner’s legal ownership of the property and is required for all mortgages.
The title fees include:
Payoff (if mortgage is being paid off)
A reverse mortgage appraisal is conducted by an FHA-approved appraiser and follows the specific FHA guidelines that require more documentation than a typical appraisal. A typical FHA appraisal costs $475-$550 depending on the state. Remote locations and properties with unique circumstances tend to cost more.
Other Closing Costs:
Like a traditional mortgage, a reverse mortgage accrues interest. However, in a reverse mortgage, the homeowner does not make payments (interest or principle) each month so the loan balance grows until the homeowner permanently moves or passes away.
Interest Rate and Mortgage Insurance:
The interest rate on reverse mortgages has fluctuated between 3%-5% over the past few years. The real interest rate is one-half of a percentage point above the quoted rate because the total rate includes FHA’s ongoing mortgage insurance premium. (For example, if the quoted rate was 4.0%, the rate with insurance is 4.5%)
*Mortgage insurance premium cost depends on disbursements.
Pros and Cons
Pros of Reverse Mortgages:
Allows the homeowner to stay in their home
Can pay off existing mortgages on the home
Simple to qualify (no minimum credit score and generally no income requirements)
No monthly mortgage payments are due (as long as the homeowner lives in the home and meets requirements for maintenance and paying property taxes and insurance)
The homeowner receives payments on flexible terms:
Can not get “upside down” on loan- heirs will never be personally liable for more than the home is sold for
Heirs inherit the home and keep any remaining equity after reverse mortgage balance is paid off
Loan proceeds are NOT taxable
The interest rate may be lower than traditional mortgages and home equity loans
Cons of Reverse Mortgages:
The fees on a reverse mortgage are the same as a traditional FHA mortgage but are higher than a conventional mortgage due to the cost of insurance. The largest costs are the FHA mortgage insurance and the origination fee
The loan balance grows over time and the value of the estate/inheritance may decrease over time
Although Social Security and Medicare are not affected, Medicaid and other need-based government assistance can be affected if too much funds are withdrawn (and not spent) in one month
The program is not well understood by most individuals
Myths and Realities of a Reverse Mortgage
Myth: The lender owns the home.
You will retain the title and ownership during the life of the loan, and you can sell your home at any time. The loan will not become due as long as you continue to meet loan obligations (such as living in the home, maintaining the home according to FHA requirements, and paying property taxes and homeowners insurance).
Myth: The home must be free and clear of any existing mortgages.
Many borrowers use the reverse mortgage loan to pay off an existing mortgage and eliminate monthly mortgage payments.
Myth: I will be taxed on the loan proceeds.
Reverse mortgage loan proceeds are tax-free as it is not considered income. However, it is recommended that you consult your financial advisor and appropriate government agencies for any effect on taxes or government benefits.
Myth: The borrower is restricted on how to use the loan proceeds.
The cash proceeds from the reverse mortgage loan can be used for any reason. Many borrowers use it to supplement their retirement income, delay receiving social security benefits, pay off debt, pay for medical expenses, remodel their home, or help their adult children.
Myth: Only poor people need reverse mortgages.
Reverse mortgages are not only for the “poor” borrower. Many multi-million dollar homes and healthy retirement assets are using reverse mortgage loans as part of their financial and estate planning.
Myth: A reverse mortgage sells the home to the lender.
The homeowner keeps the title to the home in their name. What the lender does is add a lien onto the title so that the lender can guarantee that it will eventually get paid back.
Myth: Heirs will not inherit the home.
The estate inherits the home as usual but there will be a lien on the title. The lien is whatever proceeds were received from the reverse mortgage plus accrued interest. A reverse mortgage is a “non-recourse” loan- which means that the HECM borrower (or their estate) will never owe more than the loan balance or value of the property (whichever is less); and no assets other than the home must be used to repay the loan.
Myth: The homeowner could get forced out of the home.
The HECM reverse mortgage was created specifically for seniors to live in their home for the rest of their lives. The homeowner can never be evicted or foreclosed on for non-payment.
Myth: You can outlive a reverse mortgage.
The reverse mortgage becomes due when all homeowners have moved out of the property for 12 consecutive months or passed away.
Myth: Social Security and Medicare will be affected.
Government entitlement programs, such as Social Security and Medicare, are not affected by a reverse mortgage. However, need-based programs, such as Medicaid, can be affected. The homeowner needs to manage how much is withdrawn from the reverse mortgage in one month to ensure they do not exceed the Medicaid limits. You should consult with a financial advisor for more information.
Myth: There are large out-of-pocket expenses.
Typically, the only out-of-pocket expense is the cost of counseling.
Myth: A reverse mortgage is similar to a home equity loan.
The only similarity between a reverse mortgage and a home equity loan is that they both use the home’s equity as collateral.
When is a Reverse Mortgage a Bad Idea?
There are six situations when a reverse mortgage should NOT be used:
Short-Term Needs: If you only need the money for a short period of time and then can repay the balance in full, a reverse mortgage is not for you.
Spouse Not on Title: Title to your home should be in both spouses names. A reverse mortgage must be repaid when the last person on the title moves out of the property permanently or passes away. If you were to pass away before your spouse, and they are not on title, the reverse mortgage would become due even though your spouse is still living in the property.
Don’t need the Money: If you don’t need the money right away, do not rush to take out a reverse mortgage.
Risky Investments: If you are being encouraged to get a reverse mortgage so that you can use the money to invest, you should realize that it is a large financial risk. If your home is your only asset, do not risk it.
Annuities: The reverse mortgage has a built-in annuity feature called “term” or “tenure” payments that you can use. Beware of the unethical life insurance salesmen that may encourage you to take out a reverse mortgage and then sell you an annuity.
Very Low Property Value: On low-value homes, the closing costs will be a higher percentage of the home’s equity compared to the same loan on a higher-priced home. Seniors with low-value homes should look closely at the closing costs as a percentage of their home’s equity.
Glossary of Terms
Line of Credit: A line of credit that you can make prepayments on, but those funds would not be available for future use.
Counseling: A service provided by an independent third-party, typically approved by the U.S. Department of Housing and Urban Development, to make sure the borrower fully understands the reverse mortgage and reviews alternative options, prior to application. Mandatory for the HECM program and in certain states for all types of reverse mortgages.
Equity Sharing: A feature offered in proprietary reverse mortgages that allows a borrower to receive more funds, or pay a lower interest rate, in exchange for giving up a percentage of the home’s future value. No longer offered in any reverse mortgage programs.
Initial Principal Limit: Amount of funds you are eligible to receive from a reverse mortgage before closing costs are deducted.
- Expected Interest Rate: The interest rate used to calculate the principal limit. It equals either the 10-year CMT or the 10-year LIBOR rate plus a margin.
- Actual Interest Rate: The interest rate first charged on the loan beginning at closing; it equals one of the HUD-approved interest rate indices (1-month CMT, 1-year CMT, or 1-month LIBOR) plus a margin. Also called Initial Interest Rate.
- Interest Rate Structure:
- Variable Rate: An interest rate that adjusts monthly or annually.
- Fixed Rate: An interest rate that remains constant over the life a the loan.
Line of Credit Growth Feature: In some cases, the available line of credit increases over time according to the terms of the loan agreement.
Loan Closing Date: Date on which your reverse mortgage is scheduled to close.
Maximum Claim Amount: The lesser of a home's appraised value or the maximum loan limit that can be insured by FHA. Used in determining the principal limit.
Mortgage Insurance Premium (MIP): Under the HECM program, a fee charged to borrowers that is equal to a small percentage of the maximum claim amount, plus an annual premium thereafter on the loan balance. The MIP guarantees that if the lender goes out of business, FHA will step in and ensure the borrower has continued access to his or her loan funds. The MIP further guarantees that when the property is sold to pay back the reverse mortgage, the borrower will never owe more than the value of the home.
Monthly Service Fees: A fee charged by the loan servicer for administering a loan after closing, such as disbursing loan funds, maintaining loan records and sending statements.
Net Principal Limit: Amount of funds you are eligible to receive at closing after loan costs have been deducted.Back to GlossaryNon-Recourse Loan:A feature that limits the amount owed by the borrower, heirs or estate when the loan becomes due and payable to the appraised home value. For the HECM program, non-recourse only applies when the home is sold.
Open End Line of Credit: A line of credit that allows the borrower to withdrawal funds, make payments back to the lender, and then have the ability to make subsequent withdrawals.
Origination Fee: A fee charged by the lender to cover its expenses for originating the loan. Cannot be more than 2% on the initial $200,000 of maximum claim amount and 1% on the balance thereafter with a cap of $6,000.
Prepayment Penalty: Paying off a reverse mortgage early (that is, before the borrower permanently vacates the property). Under the HECM program, there is no penalty for paying all, or a portion, of the loan prematurely.
Principal Limit: The total loan proceeds available at closing.
Principal Limit Lock: A feature that allows borrowers to lock-in the principal limit for a specific period of time.
Recordation Tax: A special assessment for recording a mortgage lien. The tax is typically paid at closing by the borrower.
Servicing Set Aside: Amount of funds estimated at closing that will be needed to service the reverse mortgage over the projected life of the loan. These funds are deducted from the initial principal limit and automatically paid each month to the loan servicer.
Subordinated Debt: A lien placed on the home behind the reverse mortgage.
Tenure Payment Option: Fixed monthly loan advances for as long as a borrower lives in a home.
Term Payment Option: Fixed monthly loan advances or payments for a specified period of time.
Title Insurance: A type of insurance policy that protects a homeowner or lender against financial loss from defects in title to real property and from the invalidity or unenforceability of mortgage liens. The cost for the policy is typically paid at closing by the borrower.